Business Entity FAQ
What do I need to know if I am going into business for myself?
You certainly need some business savvy in order to go into business for yourself. Assuming you have a good idea on how to make money, you should develop a detailed business plan before you do anything else. Going through this process will give you a much better idea of what you need to know about your business before you begin operations. Things to cover would include the following:
- capital requirements
- costs of operating
- ownership and control
- profits and losses
- labor and employment laws
- potential liability exposure
- insurance coverage
- tax consequences
- regulatory hurdles
- administrative issues
- marketing angles
Beyond all these issues, it is also extremely important for all business owners to know that they can't know everything. By definition, business is always a risky venture. The best way to quantify the risk is, when appropriate, to rely on other people for advice and consultation. Every business, for example, should have a working relationship with a lawyer, an accountant, an insurance agent and a banker.
It likewise makes sense to delegate out certain job functions when it is either cost effective to do so (for example, payroll services) or when it helps to spread the risk of your business enterprise (for example, subcontracting out part of a project when someone else will assume the risk of doing a comparable job at a cheaper price).
What form of business entity should I use?
Although maybe not the best alternative in the long run, the simplest and cheapest way to start up a business is as a sole proprietorship. A sole proprietorship means you are doing business in your individual capacity and not through any type of business entity. You may operate the business in your own name (for example, John Doe's Painting), or you may operate under a fictitious name (for example, John Doe, doing business as, or "dba" Acme Painting). Before legally doing business under a fictitious name, you are required to file a fictitious business name statement in the county or township where your business is located.
The time tested legal entity to use when forming a business enterprise is the corporation. A corporation is a legal entity that the law treats as a "person" in the sense that the organization has its own corporate identity and existence. As a separate legal entity, a corporation serves as a shield between the owners and third parties doing business with the organization. So long as corporate formalities are observed, the corporate shield makes it difficult for third parties to "pierce the corporate veil" to go after the owners. Instead, creditors and other third parties can be limited to going after the assets of the corporation. A corporation also has its' own name and identity separate from the owners. It pays taxes and has the ability to contract. It can own property. A corporation can sue and be sued. In some instances, a corporation can be charged with and convicted of crimes.
Another alternative is a partnership. A partnership is an arrangement involving two or more people undertaking a business venture as co-owners, with the intent to make a profit. The simplest type of partnership entity is known as a general partnership. Forming a general partnership is the easiest way to go into business with another person. But the simplicity of a partnership can be a problem, so careful planning is important. One of the principal drawbacks of a general partnership is that a general partner can be held responsible for all debts and liabilities of the partnership. Thus, a general partner with only a one percent interest in a business could still be held liable for 100% of the debts and liabilities of the partnership. From a tax standpoint, it's sometimes better to invest in a partnership rather than incorporating.
In order to address the issue of potentially unlimited personal liability, most states also recognize another type of business entity that is called a limited partnership. A limited partnership must have at least one general partner, but all of the other investors can be limited partners whose potential liability exposure can usually be limited to the extent of that partner's investment. So, for example, if a limited partner invests $10,000 in a business venture organized as a limited partnership, his or her potential liability would be limited to the $10,000 invested rather than the rest of the limited partner's personal assets. One of the resulting trade-offs, though, is that an investor must take a passive role in the operation of the business in order to maintain the status of a limited partner. In many ways, a limited partner is comparable to a shareholder in a corporation. Another business entity is the limited liability company. This type of business entity is perhaps best described as a hybrid of a corporation and a general partnership. It's treated as a corporation for limited liability purposes but as a general partnership for tax purposes. The owners are called "members." Unlike a shareholder or a limited partner, they don't have to take a passive role in the business.
Yet another alternative for a business entity that is sometimes overlooked is a non-profit corporation. Just because a business is non-profit doesn't mean that it can't make money. If you think your business idea might be able to operate as a non-profit entity, this is something you would want to discuss with your attorney.